Long-term investing for dummies

Don’t you love simple? When it says “plug and play” on the box, and not “read the instructions carefully”. When you can just click ‘Install’, ‘Next’ and ‘Finish’. There is elegance to a simple solution, or, to quote Alexander Pope, “a certain majesty”.

Contrary to popular belief, you can also bring ‘simple’ to your retirement investing. Warren Buffett spelt it out at his recent AGM: own broad, low cost index equity funds, ignore advisors and sit tight for the long run.

He called it the “best investment advice you will ever get”.

But the simple life is not for everyone. For the Paris Hiltons of retirement investing there is another way: rather than settle for what the markets deliver, chase Alpha. This is according to a panel of active managers speaking at the CoreShares Annual ETF Exchange Conference (reported by Moneyweb on 8 July 2016).

So what is Alpha? Delphine Govender from Perpetua gives us a glimpse: “It is the unexplained return that you cannot get from the market.” Why, you may ask, should you believe in that which cannot be explained? And who provides that return, if not the market? But it’s best if you don’t: your pursuit of Alpha should be a matter of faith, not logic.

According to Owen Nkomo of Inkuzi Wealth Group, Alpha is abundant: “We all know how inefficient the market is,” he says. Choose your “fund managers right” and you will receive an above-average return (or what remains of it, after you pay the finder’s fee).

It has been debated for many decades whether markets are efficient or not, so we are grateful to Mr Nkomo for finally settling this. Of course, not everyone will agree with him. For example: Eugene Fama, who received the 2013 Nobel Memorial Prize in Economic Sciences for his work on the efficient market hypothesis.

But that’s only a hypothesis, and, just because the majority of actively managed funds don’t beat the market, doesn’t mean you should buy into it. We all know that academics are out of touch with the real world (unlike fund managers).

In the real world, it’s also possible to identify the managers who will reliably capture Alpha. Again, this is Mr Nkomo speaking. He admits that not every manager will give you a good return. And so it must be, because for markets to be inefficient, most fund managers must be really bad at their job.  But every fund manager will endorse the underlying sentiment: ‘Mistakes are made, but not by us’

Mr Nkomo’s secret sauce for getting on the right side of this trade? “Choose your managers carefully.”

Ms Govender sheds more light: “You shouldn’t be trying to pick a manager that consistently outperforms. Alpha does not come in a straight line. Because it’s unexplained, you don’t know how it’s going to come and you can never find a manager that can deliver it all the time.”

Esoteric perhaps, but backed up with pragmatic advice: “Whatever you do, do your work and stick to it. Be smart and pick wisely. And if you are going active, be sophisticated.”

Of course, telling a lay investor to be sophisticated is a bit like telling a sick person to be healthy. Unfortunately, it gets worse: “What matters is whether the manager is outperforming the risks they are taking.”

Ah, there’s the rub that gives you pause and makes you want to pay for some real advice: Alpha is not a Pokémon monster you trap by simply following a map. It’s a four-dimensional phenomenon – a construct of place and time, risk and reward. But, apparently your broker knows where to find it.

Just don’t think that “every manager is trying to achieve the same risk-adjusted returns,” warns Peter Armitage of Anchor Capital. He too has some helpful hints: “Understand what each active manager is seeking to achieve, what their philosophy is, how they approach their investments, and the depth of the resources they have on hand to analyse shares and companies.”

Easy enough: there are only a few dozen managers in our market, and no more than fifteen hundred funds. You’ll quickly know where to invest your money.

Or not. According to Ms Govender: “Nothing guarantees outperformance. You have to create an environment that gives you better odds. Our game is a probabilistic endeavour. It’s hard to repeat, but it’s possible.”

Had CNN reported on the debate, they may have concluded as follows:  “Here’s what we know so far: Alpha is possible.”

But before you plunge into the realms of possibility, consider this: all investors together can only earn the market return. For one investor’s return to be above average, another’s must be below average. The total value of Alpha – the combined excess return available to all investors in the market – is therefore zero. What these managers offer, with their nebulous language and vague promises, and what investors spend billions of rand on, does not exist.

Yes, Alpha has been spotted many times, in many places, and almost every fund manager has a selfie posing with it on their website. But ask any one of them to deliver it tomorrow, and they’ll admit they can’t promise.

You have a choice. You can put your faith in active managers and chase this unicorn called Alpha for the next forty years.  You may get lucky every now and again, but most likely you will lose much more by way of the search and finder’s fees you will have to pay over this period. Or you can follow Mr Buffett’s simple advice, and, in all probability, do better.

Contact 10X Investments today, and start doing better.

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